Thursday, June 25, 2009

Trouble for the Dollar

A MarketWatch headline reads: "Chinese official urges buying of gold, U.S. land: report". This is, of course, a recommendation to get out of US dollar denominated financial assets and is not the first indication that China and other foreign holders of such instruments are worried.

As "AdammSmith", (underscores not allowed in screen names at this site), I posted a reply which I will copy here:

Blame for the fate of the dollar may fall on the housing and mortgage banking industries, unregulated derivatives and government's "ownership society" social engineering that created a class of weak mortgagors. All that, however, is only responsible for determining the sectors in which extreme bubble conditions occurred. The more nearly correct explanation lies with the decades long excessive use of credit and lack of savings by households, businesses and government alike guaranteeing that a bubble of some sort would be inevitable. This was enabled by persistent monetary ease by the Federal Reserve, but that, in turn, was required to maintain labor employment in an economy which could not sustain acceptable employment levels on the basis of production for consumption alone. The ultimate cause of today's economic turmoil and the dollar's falling attraction is the decades of diversion of real resources to economically unproductive use -- specifically, maintenance of US military industrial global hegemony, a relatively subtle form of empire.

Arguably, this was a justifiable cost of winning the cold war up until the collapse of the Soviet Union but since then it has been nothing but blow-back producing geostrategic games playing for the satisfaction of politicians and citizens with a lust for meddling abroad with financial benefit concentrated in defense related companies and other industries helped by an internationally bullying government in the securing of cheap foreign resources, including labor.

Empires may be very profitable for the few in the short term but are not economically sustainable for the long term. The long term results are coming into view now.

Inflationary policies mask, for a time, but do not eliminate the cost of empire. The inflation itself need not appear as a large general price increase if it is concentrated in one commodity or class of commodities, such as financial assets. That is the essence of a "bubble". A general price increase in the aftermath of a bubble burst can be avoided by a sharp monetary contraction but won't be because that is the formula for a deep recession. It can also be avoided by funds finding a speculative investment to inflate into a new bubble. This could happen with gold if there is a panic flight to perceived safety in that commodity. To some extent, not very much I think, real estate values might be re-inflated. Most likely, however, there will be inflation in prices generally. Right now this is being delayed by a classic liquidity trap. That is the meaning of the reports you see that banks are not lending. They are unintentionally preventing general price inflation by hoarding massive quantities of essentially idle funds. In time they will start to invest, since they aren't totally stupid, in inflation hedges -- mainly companies that produce basic commodities. Then excess liquidity will begin to spread to the broader economy.